When buyers of outsourced services have a primary or secondary objective of cost reduction, what are the service provider characteristics that lead buyers to believe the provider has the capability to achieve that objective? If they are successful, how do the buyers use the savings to their competitive advantage? And what factors actually produce the cost reduction? These are three questions Outsourcing Center studied from the data provided by the outsourcing relationships nominated for the 2009 Outsourcing Excellence Awards.

The data revealed some trends in connection with achieving cost savings in an outsourcing relationship, which are detailed in this article. Among the larger group of nearly 100 nominated relationships, we eliminated (a) those in existence for a period of time too short to achieve cost savings, (b) those with a primary objective of capital avoidance rather than cost reduction, and (c) relationships that did not include data on how they used the funds from cost reduction. The remaining segment provided 34 relationships to study; their data are the basis for the findings discussed in this article. They represent multinational and U.S. companies in a wide variety of industries and some government entities. Most of the 34 relationships have been in existence for more than three years, and several are into their second or third contract renewal.

How companies used the funds

Outsourcing is a means of gaining a competitive advantage. Our study revealed four primary advantages buyers realized from the cost savings they achieved in their relationships. As Exhibit 1 illustrates, 74 percent invested the funds back into research and development, developing new products, entering new markets, advanced technology or other operational aspects of the business.

Exhibit 1: Use of funds achieved in cost-reduction efforts

In comparison to the data from prior years in the Outsourcing Excellence Awards program, the data from the 2009 relationships reveals a shift in use of the funds. In prior years, increasing cash flow and using the funds as bottom-line profit were top purposes. As Exhibit 1 shows, only eight percent of buyers in this year’s study applied the funds to their cash flow and six percent to the bottom line. In contrast, 12 percent of the buyers used the funds to reduce the price of their services or products to their customers, clearly reflecting a highly competitive business arena.

Service provider selection criteria

In service provider selection decisions, two factors ranked as the top reasons for buyers with cost reduction as a primary or secondary objective: price/value proposition and process expertise. Taken together, criteria including value proposition and price of services, the provider’s willingness to invest capital (“put skin in the game”), and the provider’s commitment to savings ranked higher than the provider’s process expertise.

The table in Exhibit 2 compares the reasons for buyers’ selection of their providers in the 17 relationships that had cost reduction as the first or second objective or driver for outsourcing.

Exhibit 2: Actual reasons for selection of service providers when cost-reduction was an objective

In looking at the provider selection criteria from the perspective of how the buyers actually used the funds from the cost reduction efforts, the study revealed some significant differences. Buyers that invested the savings back into their operations or new technology, for example, placed a selection premium on the provider’s proven track record with other clients and placed little emphasis on the relationship’s cultural fit. In contrast, as Exhibit 3 illustrates, buyers that invested the funds into supporting R&D, developing new products or services, or entering new markets most often selected providers that demonstrated process expertise. These buyers also deemed technical competency as a high value.

Exhibit 3: Comparison of drivers for outsourcing with reasons for selecting service providers

Reduce costs & reduce risk of having IT knowledge in one global region

Technical skill sets & expertise in buyer’s industry

Process transformation & reduce costs

Change management methodology & proven process expertise

Increase productivity & reduce costs

Thought leadership & technical competency

Reduce costs & centralize/standardize

Commitment to productivity savings & global presence

Reduce costs & improve level of service

Provider’s skin in the game & flexibility

Reduce costs & increase flexibility

Cost of services / value proposition & scalability

Factors that led to achieving cost reduction

We asked buyers in relationships that achieved cost reduction to rank the order of four factors that led to their cost reduction. Exhibit 4 reflects that more than half of the buyers stated offshoring was the most significant factor in achieving their cost savings.

Exhibit 4: Top factor that led to achieving cost reduction

Exhibit 5 reflects combinations of the top two factors that produced savings in the relationships we studied.

Exhibit 5: Combination of top two factors that led to achieving cost reduction

Finally, among the significant findings or trends revealed in the study, we note that the combination of the provider’s expertise and aggressive pricing (cost of service), frequently deemed as the top reasons for the buyers selecting their providers (see Exhibit 3) actually led to savings in only three percent of the relationships where cost reduction was the first or second driver for outsourcing.

This facts stands out in stark contrast to the combination of 17 percent of the relationships where a combination of the provider’s expertise and a technology refresh/implementation led to cost savings (see Exhibit 5) but were not mentioned by buyers as the top two reasons for selecting their providers when cost reduction was one of the top two objectives.

Lessons from the Outsourcing Journal:

Successful outsourcing brings competitive advantages to buyers. In competitive markets, buyers that outsource with a primary or secondary driver of reducing costs most often use the funds from the savings achieved to invest back into their business in initiatives to develop new products, enter new markets, or reduce the price of products or services to their customers.

Where cost reduction is the buyer’s primary or secondary objective in outsourcing, the price of services / value proposition often ranks higher as a service provider selection criteria than process expertise.

Buyers looking to use the funds from successful cost reduction to invest into developing new products or entering new markets often rank the provider’s expertise as a top reason for selecting the provider.

Buyers looking to use the funds from successful cost reduction to invest into technology or other operational aspects of their business often rank the provider’s proven track record with prior clients as a top reason for selecting the provider.